Oil’s Big Move Today Comes Down to One Thing

Look at this headline from the Houston Business Journal last week: “U.S. Rig Count Free Falls in Texas, Oil Prices ‘Unsustainable.'”

Or this one from Bloomberg Business, which reported Sunday: “The Shale Boom Has Already Gone Bust.”

I hope you’ve learned to tune those guys out by now…

When it comes to the price of oil, there’s a pervasive market reality that these analysts seem to have forgotten.

Until this morning, that is.

As I write this, West Texas Intermediate (WTI), the New York crude oil futures benchmark, has surged more than 3% today to stand at just a shade below $61 a barrel. Meanwhile, Dated Brent, the other (and more widely used) London benchmark, is up 2.5% at more than $68.

Both are at new highs in 2015 – new highs since the first week in December 2014, in fact.

If you’ve only been reading the mainstream energy headlines, you might be surprised by this move (and your portfolio might be suffering). If you’ve been tuning in here instead, you’re in good shape.

Here’s what just happened…

The one thing raising the price of oil: geopolitics. This is all about the geopolitical once again dictating the view of oil traders.

In fact, the surge today is a result of two factors that have nothing to do with U.S. production:

Geopolitical Oil Price Factor #1: Libya

First, the Libyan factor results from the ongoing civil unrest there. Protesters, mostly looking for employment, managed to close down the last major oil exporting port, called Zueitina. It accounts for about 15% of the nation’s normal daily volume, or about 70,000 barrels a day.

Some estimates put overall Libyan production at no more than 400,000 barrels a day, less than a quarter of what had been the norm before the fighting.

The ongoing civil war, combined with a continuing (and intensifying) contest over control of the central government in Tripoli, has reduced Libyan oil exports to a fraction of what they were prior to the unrest.

The protesters have been blocking shipments on the pipeline to Zueitina, rather than at the port facility itself. Most knowledgeable observers believe the situation will end soon, as a similar protest of workers did last month at the port of Hariga and earlier at Brega.

As was the case with other unrest closing ports, Zueitina is currently filling tanker orders from available stockpiles on site. Of course, that becomes a diminishing alternative the longer the labor action lasts.

And that belies the deeper problem emphasizing how disheveled the Libyan oil infrastructure has become. Even with all ports in operation, the country can expect exports of less than 200,000 barrels a day. Much of this is the result of closures upstream, especially at the huge El Feel (or “Elephant’) field a few weeks ago.

Rising Libyan exports for a period late last year added to the downward trajectory of global oil prices. That curve is now moving in the other direction.

On the other hand, the second geopolitical factor this morning is something of an altogether different sort.

Geopolitical Oil Price Factor #2: Saudi Pricing

Saudi Arabia has raised prices for exports going to the U.S. and Europe.

The rationale given was the increase in demand noted in both regions, but the reasoning is quite at odds with the present strategy that had been coming out of Riyadh. Back last November (on Thanksgiving as it happened), the Saudis had prompted all of OPEC to hold production constant rather than cutting pumping to rise prices.

At the time, the cartel argued that cuts to maintain pricing had to come from other producers – especially the U.S. and Russia. Moscow initially obliged as its oil prospects waned in the face of a collapsing worldwide price. More recently, a greater than 30% rise in prices since the beginning of February has resulted in a resurgence.

In the case of American production, the result has been different. Despite significant cuts in forward capital expenditure commitments and the dive in the number of operating rigs in the field (shortly to surpass the huge cuts of 2008-2009), volume is increasing.

Yet, American oil still cannot directly affect global prices for one simple reason.

Aside from oil condensate (actually liquid natural gas that can be transported along with oil), heavy California oil (allowed for export at heavy discount because a sufficient domestic market is lacking), and certain minimally processed shipments (usually steam distilled), broad categories of crude oil still cannot be exported. Congress must change laws dating from the oil embargo of the early 1970s before the move out of U.S. production in large volume can occur.

[Note for Energy Advantage Members: I gave you the latest on the U.S. exports push – and the attendant profit opportunities – in the May issue. Log in here for another look.]

The battle between the Saudis and the American shale patch, therefore, is still ongoing.

And that makes the last two Saudi moves all the more interesting. OPEC’s largest producer and exporter reported last month it has increased daily lifting to 10 million barrels a day. The cartel a week later then reported that overall OPEC membership production had risen some 800,000 barrels a day.

As I noted at the time, the Saudi move to increase production was a double-edged sword. On the one hand, it was a transparent attempt to explain away the county’s inability to control OPEC members’ production in excess of monthly quotas. On the other, it was a ore hardball approach to attempt lowering prices to discipline those recalcitrant OPEC nations flooding the world with oil anyway.

That, at least, was roughly consistent with the initial policy from last November, What happened this morning is not.

By raising prices to the “developed world,” the Saudis are putting upward pressure on prices. They have done the same by lowering, and then rising, prices to Asia in the recent past.

This time there is no increase in production. But the result will have an even greater impact. It provides greater producing leverage for U.S. and Russian companies to maintain extraction levels, thereby mitigating against the larger strategy of forcing these competitors to cut.

Whether the rise in American and European demand justifies the move is debatable. But raising the price for imports is not going to make U.S. producers cut anything.

One conclusion is already clear. The days of the Saudis and OPEC controlling the global oil market by their own policy adjustments is over. The traditional “call on OPEC” has been replaced by the “call on shale” in setting price levels.

Please Note: Kent cannot respond to your comments and questions directly. But he can address them in future alerts... so keep an eye on your inbox. If you have a question about your subscription, please email us directly at customerservice@oilandenergyinvestor.com

I hope Kent can comment in the near future on the potential impact on oil prices if/when the US dollar loses its reserve status (at at least Saudi Arabia cancels the petrodollar agreement/pricing structure that they have used for decades to sell their oil to the world). How might that affect the production strategy for shale oil?

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